Is a big chunk of change worth an arm and a leg? In other words: Should you try to bootstrap your growth or go out in search of investment capital? When it comes to fundraising, that’s the question that faces many high-growth entrepreneurs. It’s not an easy question, and the answer, for you, may be different than it would have been 5 or ten years ago. It depends on your industry.
I ventured out of Silicon Valley this week to Portland, Oregon, where tech entrepreneurs are building their companies even though local venture capital is all but nonexistent. Their stories highlight some of the risks of taking venture capital and the benefits of bootstrapping, especially for companies that aren’t necessarily going to show a 10x return in five years.
Even if you think you can do a 10x return in five years, you need to be sure your VC firm will be around long enough to see you through. A lot of firms are on shaky ground right now. You don’t want your major investor to be forced into receivership, and your company’s equity to be forked over to a liquidator.
Here are four considerations when deciding whether or not to bootstrap:
What is your definition of bootstrap? For some entrepreneurs, bootstrapping means they are going to live or die by customer revenue and nothing else. Other entrepreneurs will still seek out government grants, while still others accept angel money and still feel that they are bootstrapping. There is no right answer, but it is good to be clear about it. Bootstrapping does not necessarily mean you have a lifestyle business, although some people will make that assumption. It does mean you have to be extremely disciplined about managing your finances.
What is your tolerance for cash flow crunches? There are going to be times when payments are due and revenues have not yet arrived. That’s why many companies rely on lines of credit from their banks. If you can’t stomach the idea of waiting to cash your paycheck, cash flow crunches are going to be even more stressful. So think about what, exactly, you can stomach. That will help you determine if you need outside capital and how much you need, especially if you are in growth mode.
What is the nature of your industry sector and how clear is the opportunity? Does your industry have a long sales cycle? Is your product disruptive and game-changing? Then it can take a while to generate real revenue. Figure out how you will survive until that day, and you will know if you can bootstrap. Bootstrapping gives you more flexibility to find the right product definition if you are in new territory, and you will build value by getting this right. It is sometimes hard to carry investors through the ups and downs of trying to find the right product definition.
How important is control of your company? Do you want to “report” to investors? Or do you want to be master of your own destiny? Bootstrappers endure a lot of pain to preserve control of their businesses. They tend to grow organically rather than experience rapid expansion, but this sometimes helps them outlive their competition. This fact was highlighted for me by a solar equipment company that is having their best quarter yet, even in this post-Solyndra era. Why? Because they are still standing!
You also want to keep these realities of raising venture capital in mind:
Your time. Raising venture capital takes a lot of time, even if you are careful about pitching only to firms that are still actively investing and that understand your industry. Is your time better spent getting a big customer or finding an investor? That can be a tough call, especially if a great customer could take the business to a new milestone and build a lot of value.
Need for an exit. Limited partners who provide the cash to venture firms expect returns, which means that venture capital funds have a ticking clock when they invest. Is their timeline compatible with your business growth? Or are you going to be forced into a premature exit? For sectors such as equipment, with long development and sales cycles, the timing is often out of sync. That can result in fire sale M&A situations just because an investor needs an exit. Founders and other common shareholders often lose out when this happens.
What kind of risk does the venture have? Venture investors have more appetite for market risk than for technical risk. You need to assess, honestly, which flavor of risk you’re taking on. If you have a lot of technical risk, it may be better to work through it with angel, customer, or government grant funding. Then, when it’s time to go to market with a solid product prototype in hand, you may be ready for venture capital.
Bootstrapping is not for the faint of heart, but it does allow you to preserve flexibility and control. Given the state of venture capital and the limited market for exits, it may be something that deserves your consideration.